All of A Sudden, The Fundamentals Aren’t Looking As Strong
S&P Meets Selling at February Low
Apple Plunges On First Quarter Warning
Ten-Year Treasury Yield Falls to Lowest Level In A Year
Weekly Snapshot of Global Asset Class Performance401k Plan Manager*Updated on 12/31/2018

Last year certainly unsettled investors. It started with hopes of strong and coordinated global growth. Fueled by optimism, world stock market capitalization as measured by Bloomberg sharply rose to $87 trillion.

However, reality didn’t quite match up with those expectations as global economic data disappointed economists’ consensus estimates (chart “Citi Global Surprise Index”). The narrative that emerged as a result was one where expansion in major economies is set to slow, with a marked divergence between the U.S. and the rest. Policy crosswinds, including Fed tightening, U.S. – China trade wars, and political uncertainties in the euro zone, only added volatility. Bearish sentiment accelerated in October with a combination of a hawkish Fed and little progress on the trade front. The global stock markets responded by losing over $20 trillion or 23% from peak to trough, in less than 11 months (chart “wipe out”).

Source: Bloomberg

Price momentum has turned negative for U.S., developed international, and emerging stock markets, a phenomenon not seen since 2015-2016 (chart “S&P500 MACD).

Source: Bloomberg

The U.S. economy has also started to show signs of fatigue. The regional manufacturing indexes, a leading indicator for the broad domestic economy, has sharply decelerated in December (chart “U.S. Regional manufacturing index). This suggests that manufacturers have started to factor in softening global demand, tightening financial conditions, and a waning effect of U.S. fiscal stimulus.

By now, it is also no secret that emerging markets continue to see their economies slowing as China’s PMI has also fallen into contraction territory.

The US Treasury yield curve, a widely followed recession indicator, also continues flattening.

Since September 2018, we have started to shift the focus of our fixed income management and believe that most interest rate risk is largely behind us. Given our outlook on future growth and inflation, we believe the Fed is close to its neutral policy rate. At the same time, we have started emphasizing the importance of limiting credit risk and keeping liquidity in mind at this stage of the credit cycle. This is especially true as we note the increased financial leverage in U.S. corporations. Indeed, yields have dropped significantly across the entire yield curve in last three months. Most importantly, we have seen an inversion of the yield curve between 1-year to 2-year window, suggesting that the market expects the Fed to start cutting the policy rate in 2020.

Source: Bloomberg

We also believe that there is great danger in chasing yield without being selective because corporate bonds are expensive, based on tight credit spreads. As the stock market rout deepens, the credit market selloff may follow with the credit spread widening significantly, for both investment grade and high yield bonds.

Source: Bloomberg

The recent rally in Treasuries has largely been driven by “flight to quality” rather than a change in fundamentals, in our opinion. In fact, the trade may now be over-crowded. TLT, the iShares long-term Treasury ETF, has seen the largest inflows on record, so we caution against adding meaningful duration into the portfolio at the moment.

Source: Bloomberg

Regardless of market conditions, having a sound investment discipline and maintaining adequate diversification are keys to risk management and long-term financial success. Investors hardly benefit from emotional behaviors such as return chasing and trading on headlines. The market return in 2018 precisely demonstrated this important point. In 2017, stocks in emerging markets returned 37%, outperforming US stocks by 16%. Suppose that investors overweighted emerging markets at the end of 2017 or simply did not rebalance their portfolio at the beginning of 2018. The result would have been disastrous as U.S. stocks would gain 10.5% while emerging markets lost 7.5% by end of September. If investors were frustrated with emerging market stocks and completely rotated into domestic stocks at that time, they would have lost an additional 13.5%.

Source: Bloomberg

Weekly Technical Comment

Last week’s technical comment was entitled “So, A 1000 Point Rally…Should We Be Impressed?”. It included the following at the end.

“This structure suggests that we have moved from a market where you could “Buy the dips” to a market where you may want to “Sell the rallies”.

I am not sure if a rally AFTER Christmas counts as a Santa rally but if it does we may want to “Sell the Santa rally” “

The above headline is taken from an article on Bloomberg yesterday, January 3rd which recounts all the experts assuring us during the fourth quarter that economic fundamentals remained strong in the face of heavy stock selling. Now we’re finally getting a look at some of them. And they’re not so strong. In addition to today’s report on weaker Chinese iPhone sales, Chinese manufacturing activity during December fell below 50 for the first time in nearly two years (meaning that the world’s second biggest economy is contracting). Bloomberg also reports that a gauge of U.S. factory activity for December fell to the lowest level in two years. Which is what the charts have been predicting for the last three months.

S&P Meets Selling at February Low

Chart 1 shows the recent bounce in the S&P 500 meeting overhead resistance beneath its February intra-day low at 2532 (red arrow). The same is true of other major U.S. stock indexes. That’s normal in a downtrend when previously broken support levels become new overhead resistance levels (red line). And it raises the likelihood of a retest of the December low.

Apple Plunges On First Quarter Warning

The price of Apple is plunging Yesterday, January 3rd after issuing a sales warning for the first quarter. The stock was already in trouble before that announcement. The weekly bars in Chart 2 show Apple (AAPL) falling yesterday to the lowest level since the middle of 2017. An analyst on CNBC yesterday sounded confident that the stock would do better than the rest of the market “on a relative basis”. So far, that’s not working out very well. The red line in the upper box is a ratio of Apple divided by the S&P 500. That falling ratio looks more like relative weakness to me. The stock has lost -38% since the start of October which is twice as much as the SPX. The first quarter warning came from a drop in iPhone sales in China, which is just the latest sign that weakness in that economy is starting to take a bigger bite out of earnings here. The plunge in Apple is also taking a heavy toll on semiconductor stocks and technology which is the day’s weakest sector. With other trade sensitive stocks under pressure, U.S. stock indexes are having a very bad day. From a charting perspective, yesterday’s selling is coming at a bad time.

Ten-Year Treasury Yield Falls to Lowest Level In A Year

A lot of money rotating out of stocks since the fourth quarter has moved to the safety of Treasury bonds. That trend is continuing as we start 2019. Chart 3 shows the 10-Year Treasury Yield falling to the lowest since last January. Falling bond yields are usually a sign that investors are losing confidence in the U.S. economy. Falling bond yields translate into rising Treasury prices. Chart 4 shows the 7-10 Year Treasury Bond ETF (IEF)surging to the highest level in more than a year. That’s also a sign that investors are losing confidence in the stock market.

Over the past few years, I have been writing articles on coordinating your investment discipline with your overall Financial Plan. Some of my recent articles talk about “Stress Testing” your portfolio and better aligning your overall portfolio allocation with your Financial Plan.

Over the past year, I have been called by MANY journalists asking for some of my opinions on the markets and how to help clients deal with this volatility. At STA Wealth, many of these articles are listed in our “In the News” section of our website. I also publish many of these on my twitter account @STAWealthAdv – please follow me to continue to see my thoughts. Also, if you are concerned about the markets, please call us so we can help you make prudent investment decisions aligned with your personal goals and objectives.

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC (“STA”), or any non-investment related content, made reference to directly or indirectly in this article / newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article / newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. STA is neither a law firm nor a certified public accounting firm and no portion of the article / newsletter content should be construed as legal or accounting advice. A copy of the STA’s current written disclosure Brochure discussing our advisory services and fees is available upon request. Please Note: If you are a STA client, please remember to contact STA, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. STA shall continue to rely on the accuracy of information that you have provided.

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